In the wake of President Joe Biden's significant proclamation, prohibiting US investments in specific Chinese technology segments, stakeholders across the American investment horizon have expressed concerns about the potential aftermath. For a notable Shanghai-based semiconductor startup founder, the decision beckoned an imminent transition out of China to ensure sustainable financing. This move, driven by heightened concerns over China's military accessing vital US technological resources and funding, is geared towards hampering investments into quantum computing, sophisticated chip technology, and artificial intelligence.
The Chinese Commerce Ministry said Thursday that it was “seriously concerned” about the order and that it reserved the right to take measures.
“It affects the normal operation and decision-making of enterprises and undermines the international economic and trade order.”
“This seriously deviates from the market economy and fair competition principles that the U.S. has always advocated,” the ministry said in a statement.
US investors are now faced with the challenge of recalibrating their China portfolios. Over recent years, leading private equity entities, including General Atlantic, Warburg Pincus, and the Carlyle Group, have considerably enriched China's technological sector. However, with the evolving political scenario, there's a significant decline in investment, as illustrated by Dealogic's figures, indicating a sharp drop from $47bn in 2021 to just around $2.8bn this year.
The unfolding landscape prompted Sequoia Capital's strategic pivot, distancing its China and India operations from its US and European endeavours. This decision marks a pivotal shift, prompting industry insiders to speculate the end of an era where US venture capital firms actively invest in China.
However, even as some firms, like Sequoia, reposition, many, including GGV Capital, GSR Ventures, and Qualcomm Ventures, remain invested, though not without scrutiny from the US Congressional Committee on Chinese investments.
For their part, US investors are trying to work out the potential impact of Biden’s order on their holdings in China and weighing up strategies to comply or exit.
The recent US directive, outlined as a "small yard, high fence" approach by Jake Sullivan, is ostensibly limited to three primary sectors. Still, the inclusion of AI, a pervasive and dual-use technology, amplifies the uncertainty for potential US investors. For instance, the overlap between civilian and military use of AI in logistics and warehousing brings ambiguity into investment decisions.
Moreover, for US public pension funds acting as "limited partners" in these investments, the grey area revolves around the nature and degree of influence they have on Chinese fund operations. While the administration doesn't seem keen on curtailing purely financial contributions without operational influence, a distinct threshold is expected to be set in the final rule.
According to officials, the primary focus on private equity and venture capital firms stems from the 'intangible' benefits these firms can offer Chinese entities, including invaluable networking with experts.
However, some, including Republican Mike Gallagher, Chairman House Select Committee on the Chinese Communist Party believe that the existing restrictions might not effectively slow China's military modernization. Thus, there's a push for more comprehensive regulations encompassing public market investments.
The recent US directive, outlined as a "small yard, high fence" approach by Jake Sullivan, is ostensibly limited to three primary sectors. Still, the inclusion of AI, a pervasive and dual-use technology, amplifies the uncertainty for potential US investors. For instance, the overlap between civilian and military use of AI in logistics and warehousing brings ambiguity into investment decisions.
Moreover, for US public pension funds acting as "limited partners" in these investments, the grey area revolves around the nature and degree of influence they have on Chinese fund operations. While the administration doesn't seem keen on curtailing purely financial contributions without operational influence, a distinct threshold is expected to be set in the final rule.
According to officials, the primary focus on private equity and venture capital firms stems from the 'intangible' benefits these firms can offer Chinese entities, including invaluable networking with experts.
However, some, including Republican Mike Gallagher, believe that the existing restrictions might not effectively slow China's military modernization. Thus, there's a push for more comprehensive regulations encompassing public market investments.
If American capital continues to flow to Chinese military companies, we are at risk of funding our own destruction. - Chairman Mike Gallagher (R-WI) of the House Select Committee
Given the uncertain regulations, Jonathan Gafni of Linklaters anticipates extensive discussions and push backs in the coming months. The broader implications of the new ban may make investors reconsider future commitments to new private equity funds.
Gallagher called on the President to prioritise transparency while adopting several core principles in the executive order,
“I urge you to take meaningful first steps towards effective and balanced outbound investment rules in the interim.” Senator Gallagher Outlined.
Marcia Ellis from Morrison Foerster suggests that investors may incorporate side-letters, specifically omitting investments in China's controlled sectors. Meanwhile, Jonathan Gafni, who leads the US foreign investment practice at Linklaters, believes lobbyists will have ample time in the upcoming months to deliberate on the finalised regulations.
Gafni said lobbyists would have plenty of opportunity to consider the final rules over the coming months.
“[The administration] are not putting too firm a stake in the ground yet because they realise that there is going to be a lot of pushback if the application is too broad.” -Jonathan Gafni, head of the US foreign investment practice at the law firm Linklaters
In a broader business context, it's imperative to recognize the potential global implications of market restrictions. As the US tightens its market access, China may strategically realign with more receptive regions, potentially strengthening its ties with markets like the Middle East. Several academic and political analyses indicate that aggressive trade sanctions, driven by geopolitical competitive agendas, could inadvertently enhance Sino-Middle Eastern partnerships in AI and pivotal tech sectors.
Such a shift could herald the creation of a new technological epicentre or a second techno-political track, altering the global technological equilibrium.
In line with these developments, Beijing's regulatory clampdown is already manifesting its effects. Intel announced its decision to halt the acquisition of Israeli chipmaker, Tower Semiconductor, valued at $5.4bn, due to its inability to obtain regulatory clearance in China.
The acquisition had yet to be signed off by the Chinese competition regulator, said two people briefed on the matter. Officials in Beijing have been scrutinising any transaction that could hand greater control over the semiconductor supply chain to Washington.
Geopolitical tensions, coupled with regulatory clampdowns on overseas listings and due diligence firms in China, suggest that the ripple effect of the current US policy is profound. As one equity fund advisor puts it, “US investors are already hesitating on new China-based opportunities."
National security policies are significantly influencing the economic landscape, introducing a volatility that global funds find challenging to navigate. These dynamics could inadvertently disadvantage the West, while paving new avenues of opportunity towards the East.
The insatiable demand for semiconductors and advanced circuitry will give rise to new economic centres. These hubs will attract not just traditional pension funds but also burgeoning capital players from the Middle East, keen to collaborate with China.
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